INITIAL DECISION RELEASE NO. 113
ADMINISTRATIVE PROCEEDING
FILE NO. 3-9060
UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________
:
In the Matter of :
: INITIAL DECISION
FREDERICK C. GARTZ : August 6, 1997
:
_________________________:
APPEARANCES: Robert J. Burson, Joy M. Boddie, and Gregory P. von
Schaumburg for the Division of Enforcement, Securities
and Exchange Commission
Stanley T. Padgett for Frederick C. Gartz
Timothy P. Burke for PaineWebber Inc.
BEFORE: Brenda P. Murray, Chief Administrative Law Judge
The Securities and Exchange Commission ( Commission ) initiated this
proceeding on August 12, 1996, pursuant to Section 8A of the Securities Act
of 1933 ( Securities Act ) and Sections 15(b), 19(h), and 21C of the
Securities Exchange Act of 1934 ( Exchange Act ).
I held a hearing in Naples, Florida, on October 21, 22, and 23, 1996.
The Division of Enforcement ( Division ) presented testimony from nine
witnesses and introduced eighty-one exhibits. Frederick C. Gartz ( Mr.
Gartz ) presented four witnesses and introduced twenty-three
exhibits.
I received the Division s Post Hearing Brief and Proposed Findings of
Fact and Conclusions of Law on November 25, 1996; the Respondent s Post
Hearing Brief and Proposed Findings of Fact and Conclusions of Law on
Citations are to the hearing transcript (Tr. __) and to the
exhibits admitted into evidence at the hearing. The Division s
exhibits are (Div. Ex. __), and the Respondent s exhibits are
(R s Ex. __).
======END OF PAGE 1======
December 24, 1996; and the Division s Reply Brief on January 22,
1997.
Issues
Whether Mr. Gartz violated the antifraud provisions of the securities
statutes in twelve transactions that occurred from August 12, 1991, until
approximately January 1992, by (1) selling to customers illiquid
investments with a significant degree of risk which were unsuitable in
light of their age, financial condition, and stated conservative investment
objectives and which caused an excessively high concentration of this type
of investment in their accounts; (2) selling investments at higher than
market prices and failing to seek or obtain the best price reasonably
available under the circumstances; (3) representing both the buyer and the
seller in transactions and thus impermissibly benefiting one customer to
the detriment of the other; and (4) failing to disclose to buyers that they
were not paying the most favorable prices available.
Findings of Fact
My findings and conclusions are based on the record and hearing the
witnesses testimony and observing their demeanor. I applied preponderance
of the evidence as the applicable standard of proof.
PaineWebber Inc.
PaineWebber Inc. ( PaineWebber ) is a registered broker-dealer and a
member of the New York Stock Exchange, Inc., the National Association of
Securities Dealers, Inc. ( NASD ) and all other major stock, options, and
futures exchanges. In 1991-92, PaineWebber employed approximately 4,800
registered representatives in several hundred retail branch offices. (Tr.
299.)
On January 17, 1996, the Commission, pursuant to Section 8A of the
Securities Act, and Sections 15(b), 21B, and 21C of the Exchange Act,
entered an Order Instituting Public Administrative Proceedings, Making
Findings, Imposing Remedial Sanctions, and Issuing Cease and Desist Order
( Settlement Order ) against PaineWebber. (R s Ex. 2; PaineWebber
Incorporated, 61 SEC Docket 179 (Jan. 17, 1996).) PaineWebber consented to
the order without admitting or denying the findings it contained. The
Commission found that between 1986 and 1992, PaineWebber violated the
antifraud provisions of the federal securities laws, Section 17(a) of the
Securities Act and Sections 10(b) and 15(c)(1) of the Exchange Act and
Rules 10b-5 and 15c1-2 thereunder, in that its:
The Briefs are very difficult to use effectively because none
of them include a table of contents, an alphabetized table of
cases, a table of statutes, and a table of other authorities
cited as required by the Rules of Practice. 17 C.F.R.
201.152(e).
Mr. Gartz was not a party to the settlement but he introduced
it into evidence in this proceeding. (Tr. 293.)
======END OF PAGE 2======
sales and marketing materials for four families of direct
investments -- PaineWebber/Geodyne oil and gas programs,
PaineWebber Insured Mortgage Partners, PaineWebber/Independent
Living Mortgage, and Pegasus Aircraft Partners -- overstated
benefits and understated risks of the investments, and
characterized certain direct investments as suitable for
conservative investors without sufficiently disclosing the risk
of loss of principal. In addition, PaineWebber sold direct
investments (including, but not limited to, those mentioned
above) to numerous investors for whom they were unsuitable and in
concentrations too high given the investors age, financial
condition, sophistication and investment objectives. . . .
PaineWebber also violated Section 17(a) of the Exchange Act and
Rule 17a-3 thereunder by failing to make and keep certain
required records of purchases and sales of direct investments on
the secondary market.
(R s Ex. 2, Exhibit A at 2-3.)
The Settlement Order found further that PaineWebber failed:
reasonably to supervise ten [registered representatives] (two of
whom were branch office managers . . . ) in eight branch
offices, who engaged in fraudulent sales practices in
connection with certain retail customer accounts.
(R s Ex. 2, Exhibit A at 3.)
Among other things, the Settlement Order obligated PaineWebber to pay
an aggregate of $292.5 million for the benefit of purchasers of direct
investments that it sold and to pay a civil penalty of $5 million. (R s.
Ex. 2, Exhibit A at 29-30.) In addition, PaineWebber agreed to pay $75
million in non-cash benefits to direct investment purchasers as part of a
class action settlement of litigation involving its direct investments.
(R s Ex. 3; R s Proposed Findings of Fact at 5.)
Respondent
Mr. Gartz completed three years of undergraduate study at the
University of Notre Dame in South Bend, Indiana. He served in the U.S.
Army in Vietnam in 1966-68, and later received a Bachelor of Science
degree in business management from Saint Joseph s College in Rensselaer,
Indiana. Mr. Gartz s first employer was the Naples, Florida office of
McCormick & Co., in 1971. When the Naples office of McCormick & Co. became
part of PaineWebber in 1975, Mr. Gartz became the office manager, a
position he held until the end of 1991. (Tr. 637-38.)
The branch offices were: Miami, Florida; Flint, Michigan;
Naples, Florida; Grand Rapids, Michigan; Tampa, Florida; Omaha,
Nebraska; Spokane, Washington; and Sioux City, Iowa. (R s Ex. 2,
Exhibit A at 16-24.)
He received the Bronze Star Air Medal and the Vietnam
Campaign Medal. (Tr. 636-37.)
======END OF PAGE 3======
Mr. Gartz was a producing branch manager in that a major part of his
income came from his activities as a broker. In 1990-91, Mr. Gartz advised
between 300 to 400 clients with approximately $80 million of invested
assets. (Tr. 301, 640-41.) Direct investments were one of Mr. Gartz s
main areas of activity, and he estimated that his clients placed about $7
to $8 million of their total assets in this type of security. However,
PaineWebber officials believed the amount to be considerably higher.
PaineWebber s vice president of the Direct Investment Department ( D.I.
Dept. ) knew Mr. Gartz in 1991 because Mr. Gartz and the Naples office sold
a lot of direct investments. (Tr. 389.) PaineWebber s deputy
director of compliance estimated that Mr. Gartz sold between $25 and $30
million of direct investments which he believed was a high amount. (Tr.
301-02.) Mr. Gartz bought small amounts of direct investments for his own
account. (Tr. 695.)
Mr. Gartz s income from PaineWebber was $218,010 in 1990 and $211,810
in 1991. He earned a $50,000 bonus in 1991 which he did not take because
he didn t feel that it was the right thing to do under the circumstances .
. . because [he] caused [PaineWebber] a lot of trouble. (Tr. 683-84.) In
1993 and 1994, Mr. Gartz had income from wages of $8,613 and $3,135,
respectively.
Mr. Gartz s record of community involvement includes service as
president of the local Rotary Club and Catholic Social Services; on the
board of several churches, church-related schools, the local Y.M.C.A. and
United Way; as president and board member of the civic association in the
community in which he resides; as chair and board member of the community s
development district, a governmental body authorized to issue development
bonds; and as a member of the county planning commission. (Tr. 638-40.)
PaineWebber placed Mr. Gartz on disability leave status in January
1992 on condition that he seek inpatient treatment for alcoholism.
(Tr. 319.) In March 1992, he spent three weeks in an inpatient facility
where he was diagnosed as an alcoholic at the severe stage. (Tr. 680, 738;
R s Ex. 24.) PaineWebber ended Mr. Gartz s employment some time prior to
March 1992. (Tr. 684, 746.)
Since July 1992, Mr. Gartz has been employed as an insurance agent
with Northwestern Mutual Life Insurance Co. He uses his Series 6 license
which is registered with the insurer s broker-dealer subsidiary,
Northwestern Mutual Investments Services, Inc., to sell variable annuities
and variable life products. (Answer at 3; Tr. 685.) Mr. Gartz believes
that his employer will terminate his employment if he loses his securities
D.I. Dept. is now known as the Private Investments
Department. The terms are synonymous.
The income information is from copies of Mr. and Mrs. Gartz s
joint federal tax return. (R s Ex. 33.)
The PaineWebber Compliance Department official sent to Naples
in the fall of 1991 found a gun in Mr. Gartz s desk and the
official became concerned about his personal safety. (Tr. 318-
19.)
======END OF PAGE 4======
licenses. (Tr. 685.)
On September 30, 1993, District 7 of the NASD informed Mr. Gartz that
it had concluded that no action against him was warranted based on its
investigation of the circumstances disclosed in the Form U-5, Uniform
Notice of Termination of Registration, which PaineWebber filed when Mr.
Gartz left his employment. (R s Ex. 32.)
Direct Investments or Private Placements
PaineWebber sold approximately $3 billion of direct investments
between 1986 and 1992. (R s Ex. 2, Exhibit A at 3.) PaineWebber s direct
investments referred to certain limited partnerships and real estate
investment trusts which PaineWebber marketed aggressively through its D.I.
Dept. and which it sold to customers through its network of registered
representatives. PaineWebber s registered representatives believed they
could rely on the D.I. Dept. s marketing materials and informational
meetings, and they did so. (Tr. 555-58.)
In 1991-92, PaineWebber s direct investments at issue had certain
common characteristics:
* they were proprietary or affiliated offerings because PaineWebber
subsidiaries or affiliates were the sponsors, advisors, and/or the general
partner of each of the issuers. (Tr. 272; Div. Exs. 70 at 60, 72 at 13;
R s Ex. 2, Exhibit A at 3.)
* they were illiquid because they were not publicly traded, i.e.,
they were not listed on any exchange or listed on NASDAQ. (Tr. 264-66,
277; R s Ex. 2, Exhibit A at 3.) Until November 1991, PaineWebber operated
a direct investment information system ( DIN ) or matching program which
listed direct investment sellers, their offering price, and the account
representative on an in-house electronic bulletin board which was available
on brokers workstations and Quotron machines in all PaineWebber offices.
(Tr. 265-72.) The DIN system also showed the price in the three most
recent trades on sales where the broker sought a commission. (Tr. 408-09.)
* customers believed that their holdings were valued at the amount
shown on their statement, however the statements noted in very small print
that the asset value of some direct/private placements were shown at
original cost. (Tr. 247-49, 257, 409-11, 449-451, 465.)
Record does not show what licenses he holds in addition to
the Series 6.
The following appeared amid a lot of text on the back of the
statement:
Values presented for insurance products, annuities, and
private investments (direct investments) are provided
by the insurance company or sponsor (sources considered
reliable) and the accuracy is not guaranteed.
Generally, direct investment prices are listed at
initial offering price for the first 3 years. Prices
(continued...)
======END OF PAGE 5======
PaineWebber showed par values even though it maintained sales records that
showed that units of the direct investment sold for less than par during
the period. (Div. Ex. 67.)
* transfers of direct investments required that both the buyer and
the seller sign letters of authorization and transfer documents, and that
the general partner of the issuer approve the transfer. (Tr. 181.) The
account executive is responsible for getting the documentation to the
general partner. (Tr. 203.) The approval process should take from 30 to
60 days. (Tr. 180-82.) The transfer of funds from the buyer to the seller
should occur after the general partner approved the transfer, but in the
transactions at issue where Mr. Gartz was the account executive, the funds
were transferred to the seller before this occurred. (Tr. 269, 421.)
* they were not marginable securities. (Tr. 173.)
Transactions
Mr. Gartz controlled each of the accounts at issue because the
customers trusted him and always followed his advice. A registered
representative may control an account when a customer relies upon the
broker to such an extent that the broker is positioned to control the
volume and frequency of the transactions in the account or where the
customer routinely follows the representative s recommendations. John M.
Reynolds, 50 S.E.C. 805, 806 (1992); Donald A. Roche, 64 SEC Docket 2042,
2049 n.14 (June 17, 1997).
Mr. Gartz read each of the Prospectuses word for word and reviewed
other materials before recommending that his customers buy PaineWebber
direct investments. (Tr. 90-91.) When his customers requested that he
sell their direct investments, Mr. Gartz did not use PaineWebber s in-house
DIN system to check what other sellers were asking for similar units. In
all but one transaction, Mr. Gartz arranged the sale to another of his
customers and he represented both the seller and the buyer. In all sales,
Mr. Gartz had the buyer pay the original offering price for the units.
(Tr. 672.) Mr. Gartz did not benefit financially from any of the
transactions because he did not charge the buyer a commission when a
maximum seven percent commission was allowed. (Tr. 277, 672-73.)
The transactions at issue occurred in the secondary market and
involved the following PaineWebber direct investments:
(...continued)
may or may not represent current or future market
value. To obtain current quotations, when available,
contact your Investment Executive.
(Div. Ex. 25.)
PaineWebber claims it showed direct investments at original
cost for the first three years in accord with the Investment
Program Association convention. It no longer does so. (Tr. 409-
11.)
======END OF PAGE 6======
A. PaineWebber Independent Living Mortgage Fund, Inc.
( Independent Living Mortgage )
Independent Living Mortgage was a 1989 issue totaling $50 million
offered at ten dollars per share, at a minimum investment of five thousand
dollars, for a real estate investment trust formed to make construction and
participating mortgage loans secured by real estate. (Div. Ex. 72.)
Independent Living Mortgage expected to make all or most loans to Angeles
Corporation ( Angeles ), a development company, to acquire or develop
rental housing units for independent senior citizens.
The Prospectus noted that this investment involved risks in addition
to the general risk associated with real estate that the property would
generate insufficient income to cover expenses. (Div. Ex. 72 at 21.) The
construction loans to be made were more risky than loans secured by real
estate on which improvements had been completed. (Id.) Also, there was a
risk from lack of diversification in that the loans would go exclusively to
Angeles, and that the success of the enterprise depended on the expertise
of Angeles s wholly owned subsidiary, Angeles Housing, a recently organized
company with limited experience in the field of senior housing. (Div. Ex.
72 at 6, 14.) In addition, the default risk would be greater because the
investments may be secured by properties of the same type located in the
same general geographic area. (Div. Ex. 72 at 14.)
The Prospectus noted that there was no assurance that the issuer would
achieve its investment objectives, and that it anticipated that investors
would receive a quarterly ten percent yield on their investment based on a
commitment by Angeles. (Div. Ex. 72 at 4.) The Prospectus noted that the
performance of Angeles was of substantial importance to Independent Living
Mortgage, and that Angeles s maximum aggregate liabilities amounted to 3.6
times its book net worth. (Div. Ex. 72 at 5.) At the hearing, Mr. Gartz
described Angeles as a $4 billion publicly traded company, and stated that
PaineWebber s D.I. Dept. represented to brokers that Angeles guaranteed
that unit holders would receive a ten percent return for the first four
years. (Tr. 648.) In fact, the Prospectus for a later offering,
Independent Living Mortgage II, issued in 1990, put Angeles s book net
worth at $32 million. (Div. Ex. 73 at 21.)
The Independent Living Mortgage Prospectus specified that the offering
was suitable only for persons or entities of adequate means having no need
for liquidity of their investment. (Div. Ex. 72 at 7.) It explained that
because it did not expect a public trading market for shares to develop, an
owner may not be able to sell shares readily and, therefore, the purchase
This later Prospectus dated August 8, 1990, estimated
Angeles s commitments to be six times its net worth of $32
million. (Div. Ex. 73 at 7, 21.) PaineWebber s marketing
materials for Independent Living Mortgage II advertised the
securities as a way to lock in a ten percent yield in a time of
falling interest rates. (R s Exs. 11, 18.) Angeles Housing
reported a net loss for each of its first three fiscal years and
in 1990 it expected to report net losses from operations for the
next four to five years. (Div. Ex. 73 at 22.)
======END OF PAGE 7======
should be considered a long-term investment. (Div. Ex. 72 at 18.) The
Prospectus s discussion of the reinvestment plan noted that investors
should not assume that they would be able to sell their shares to the
Reinvestment Agent in the future, but that the latter would attempt to
match buy and sell orders. However, this service did not constitute a
market that investors could rely on to sell their shares. (Div. Ex. 72 at
A-2.)
1. The Sullivans
Father Richard K. Sullivan, a Roman Catholic priest, opened a joint
account with his 88 year old mother at PaineWebber in June 1991.
Father Sullivan chose Mr. Gartz as the account executive because he knew
Mr. Gartz from his activities in the church where Father Sullivan was
stationed. The account held $50,000 that Mrs. Sullivan had received from
the sale of her home. Mrs. Sullivan s only other assets were certificates
of deposit of about $40,000 and annual pension income of about $6,480.
Father Sullivan told Mr. Gartz that their investment objective was to have
the account provide sufficient income to pay his mother s housing costs.
Father Sullivan, who acted for his mother in managing the account, was
not knowledgeable about securities. Father Sullivan trusted Mr. Gartz to
invest the funds in safe, low risk investments which would accomplish the
account s purpose. He accepted and followed Mr. Gartz s investment advice
and signed whatever documents Mr. Gartz asked him to sign. (Div. Ex. 36 at
15-16, 24-25.) Relying on Mr. Gartz s advice, Father Sullivan transferred
the entire $50,000 from the Sullivan s PaineWebber Money Market account and
purchased units of Independent Living Mortgage sometime after June 1991.
(Div. Ex. 36 at 17-18.) Mr. Gartz arranged for the Sullivans to purchase
the units from the account of Elsie Barker, another of his clients.
PaineWebber s deputy director of compliance, who was sent to review
Mr. Gartz s accounts in the fall of 1991, found the documentation for this
transaction confusing. (Tr. 160-80.) The Barker letter of authorization
for the transfer of units to the Sullivan account is dated May 2, 1991.
(Div. Ex. 34.) However, the Sullivans signed the letters of authorization
for the sale of their Money Market and purchase of the units on August 6
and August 20, 1991, respectively. (Div. Ex. 34.) Records for the account
indicate that the Sullivans sold shares in their Money Market account on
August 8, 1991, and received Independent Living Mortgage units in their
account on December 19, 1991. (Div. Ex. 35.)
The Sullivans received the expected nine or ten percent return on
Independent Living Mortgage initially, but the return dropped to less than
four percent, and Father Sullivan asked PaineWebber to buy the securities
back after Independent Living Mortgage went into receivership in 1993 or
1994. The Sullivans did not suffer any financial loss because PaineWebber
The parties agreed to the admission of Father Sullivan s
testimony in the form of a videotape and transcript of his
deposition taken on October 16, 1996, subject to my ruling on the
objections made at the deposition. (Div. Exs. 36, 36A; Tr. 524-
26.) I find that the objections provide no reason to strike the
witness s testimony.
======END OF PAGE 8======
purchased the units back at their request on March 7, 1994. (Div.
Ex. 36 at 32, 35.)
2. Marjorie Moore
The evidence contains a letter of authorization dated October 23,
1991, from Marjorie Moore, a customer of Mr. Gartz, directing the transfer
of $5,000 from her account to the Sullivan account for purchase of
Independent Living Mortgage. (Div. Exs. 39, 40.) Father Sullivan did not
authorize the sale, was unaware that it occurred, and did not know that a
$5,000 transfer by Ms. Moore into the account was the source of the $1,250
check his mother received in October 1991. (Div. Exs. 35 and 36 at 25-26.)
The preponderance of the evidence supports the Division s claim that
Mr. Gartz arranged for Marjorie Moore to buy 500 units of Independent
Living Mortgage from the Sullivans because the Sullivan account contained
only $462 after he had them buy $50,000 worth of Independent Living
Mortgage in August. Mr. Gartz made the sale to Marjorie Moore to get money
to pay the Sullivans what they thought was interest on their units of
Independent Living Mortgage in October 1991. (Division s Proposed Findings
of Fact at 13-14.)
3. Marguerite M. Adams
Mrs. Adams and her husband opened a joint account at PaineWebber with
Mr. Gartz as account executive in 1988 or 1989. While her husband was
alive, Mrs. Adams did not have any dealings with Mr. Gartz about the
account. (Tr. 252.) In March 1991, the account held $40,000 in two direct
investments, Pegasus Aircraft Partners II, L.P. ( Pegasus ) and Corporate
Property Associates-10 ( CPA-10 ), and $5,000 in a Money Market fund. (R s
Ex. 1.)
Mr. Adams died in April 1991 and Mrs. Adams had Mr. Gartz change the
account to a single account in her name in June or July 1991. (Div. Ex.
22.) At the time she was 66 years old, a homemaker with an annual income
of between $18,000 and $20,000, and her total assets of about $100,000 were
in her PaineWebber account. (Tr. 221-22, 225-26, 250-51.) She did
not own a home. Her investment objective was to obtain income and she did
not want to take any risk. (Tr. 229.)
In the summer of 1991, Mr. Gartz called and suggested to Mrs. Adams
that she take money from her money market account, where she had placed Mr.
Adams s life insurance proceeds, and invest in Independent Living Mortgage
because it would pay a higher rate of interest than the money market was
paying, ten percent rather than four or five percent. (Tr. 230-33.) Mrs.
Adams consulted with her son, who urged her to get more information,
The Sullivans quarterly returns went from $1,250, or 10
percent, to $450, or 3.6 percent. (Div. Ex. 36 at 34.)
Mrs. Adams testified that the new account form erroneously
stated her net worth at $300,000, her liquid income at $60,000,
and her annual income at $50,000. (Tr. 225-26; Div. Ex. 22.)
======END OF PAGE 9======
especially about liquidity. (Tr. 232.)
Mrs. Adams authorized the purchase on August 6, 1991, after Mr. Gartz
assured her that she would be able to the redeem her units within a fairly
good time because [she] didn t want to tie up [her] money that [she]
couldn t get it out if [she] needed to. (Tr. 231.) Mr. Gartz assured her
it would not take that long to sell if something came up and she needed to
get her money out, and she took this to mean that she would have her money
within a month. (Tr. 231-33, 252.) He represented that this was the last
of a new offering. Mrs. Adams asked for a Prospectus but never received
one. (Tr. 232.)
Mr. Gartz arranged for Mrs. Adams to buy units of Independent Living
Mortgage at $10 a unit from the account of another of his customers,
Alexander Hirst. The sum of $11,150 was transferred from Mrs. Adams s
account on August 8, 1991, and the account received units of Independent
Living Mortgage on December 6, 1991. (Div. Exs. 25, 27.) In December 1991,
76 percent of Mrs. Adams s total assets were in direct investments. (Div.
Ex. 25.)
From at least April 1991 until August 1991, when the money from Mrs.
Adams was transferred into the Hirst account, the Hirst account had a debit
balance. One of only two possible explanations is that Mr. Gartz authorized
a check disbursement out of the account before he could find a buyer for
the units, and then he had Mrs. Adams buy the units to cover the debit
balance in the account. (Tr. 186-89.) This unusual occurrence is
not a sound business practice. (Tr. 186-87.)
Mrs. Adams did not suffer any financial loss because PaineWebber
bought the units back from her after she complained when the returns on
Independent Living Mortgage dropped precipitously after December
1991. (Tr. 247-48.)
4. Thomas Frazee
Thomas Frazee, opened an Individual Retirement Account ( IRA ) at
PaineWebber with Mr. Gartz in about 1980, six years before he retired. The
account had assets of $300,000 to $350,000. Mr. Frazee also had securities
valued at about $150,000 in an account with another brokerage firm. Mr.
Frazee told Mr. Gartz he was a conservative investor interested in safety
and preserving capital, and who wanted his investments to generate income.
(Tr. 478.)
The other possibility is that the original trade was never
paid, but there is no evidence that this occurred.
PaineWebber also bought back her units of Pegasus and CPA-
10. (Tr. 249.) Mrs. Adams was upset to learn that the quarterly
payments had included a partial return of principal. (Tr. 248.)
In 1993, some PaineWebber brokers in the Naples office were upset
to learn that quarterly distributions on PaineWebber Insured
Mortgage Partners included return of principal. (R s Ex. 8; Tr.
552.)
======END OF PAGE 10======
When Mr. Gartz called in November 1991 and recommended that he buy
$50,000 worth of Independent Living Mortgage, Mr. Frazee asked about
liquidity because he was concerned that he might already own sufficient
direct investments. (Tr. 490-91.) He already owned $45,000 worth of
Geodyne I/P-1, $50,000 worth of Independent Living Mortgage Inc. II,
and one more which he had purchased on Mr. Gartz s recommendation.
(Tr. 487, 490-91; Div. Ex. 10A.) Mr. Frazee s notes from a November 14
conversation with Mr. Gartz where the latter claimed that PaineWebber
guaranteed that (1) Independent Living Mortgage would pay a 10 percent
return, and (2) it would repurchase the units for what he paid at the end
of any quarter, appear to have been taken in 1990 not 1991. (Tr. 480-82,
498-501, 657-58.) Even though 1990 is outside the time period when the
alleged violations occurred, Mr. Gartz does not contend that he corrected
this false and misleading information when he urged Mr. Frazee to purchase
Independent Living Mortgage in 1991. (Tr. 657-58.)
Based on Mr. Gatz s advice, Mr. Frazee purchased $50,000 worth of
Independent Living Mortgage on November 20, 1991. (Div. Ex. 7.)
Mr. Gartz arranged for Mr. Frazee to purchase the units from the account of
another of his customers, Sarah a/k/a Sally Coffey, at the original unit
cost of $10. Ms. Coffey had sent Mr. Gartz a written directive to sell the
two direct investments in her account, Independent Living Mortgage and
PaineWebber Insured Mortgage Partners on April 20, 1991, because she needed
the funds for a real estate purchase. (Div. Ex. 4.) Mr. Gartz
advised her to wait until after June to sell so that she would receive
interest for the quarter, and told her that it would take a week to sell
the units. (Tr. 448, 453.) Ms. Coffey was surprised to learn at the end
of the summer that she still owned the units and she called Mr. Gartz to
find out why, but did not get a satisfactory answer. (Tr. 454.)
Mr. Frazee later complained to PaineWebber about his direct
investments. As a result, PaineWebber offered to buy back his units of
Geodyne and either Independent Living Mortgage or Independent Living
Mortgage II. (Tr. 492.) In October 1996, Mr. Frazee owned Independent
Living Mortgage which was valued at between $20,500 and $30,500. (Id.)
The Settlement Order refers to twenty-nine PaineWebber oil
and gas limited partnerships referred to as Geodyne Institutional
Pension Programs ( IP ) and Geodyne Energy Income Programs. (R s
Ex. 2, Exhibit A at 4.)
The units were transferred into his account in January 1992.
(Div. Exs. 3, 10C.)
In the same certified mail letter, Ms. Coffey directed Mr.
Gartz to consolidate the joint account she had with her mother
with her account. (Tr. 448.) Ms. Coffey s parents, who died in
1990 and 1991, had been customers of Mr. Gartz. Her mother added
Ms. Coffey s name to her account in the late 1980s when Ms.
Coffey s husband was diagnosed with lung cancer. Ms. Coffey has
six children.
======END OF PAGE 11======
B. PaineWebber Insured Mortgage Partners 1A
( Insured Mortgage Partners )
Insured Mortgage Partners was a 1987 offering totaling $250 million
dollars to fund two series of limited partnerships which invested in a
diversified portfolio of federally insured or coinsured mortgage loans
through the purchase of Government National Mortgage Association ( Ginnie
Mae ) securities. (Div. Ex. 71 at 1; Tr. 101.) The offering was
sold at one hundred dollars a unit, with a five thousand dollar minimum for
individual investors.
The Prospectus indicates that the general partner anticipated having
to have the units listed on NASDAQ within twelve to thirty-six months, but
it specified that there was no assurance that a public trading market would
develop. (Div. Ex. 71 at 3, 24.) The units were, in fact, never traded
publicly. (Tr. 101, 266.) The Prospectus which Mr. Gartz read warned
that:
Unitholders may not be able to liquidate their investments in the
event of an emergency. In addition, if the Units are not listed
on NASDAQ, the Units may not be readily accepted as collateral
for a loan. Consequently, the purchase of Units should be
considered only as a long-term investment. Furthermore, even if
a market for the sale of Units were to develop, there can be no
assurance given as to the value which a Unitholder could receive
for his Unit.
(Div. Ex. 71 at 24-25.)
Contrary to the cautionary statements in the Prospectus, PaineWebber s
D.I. Dept. circulated to registered representatives materials aimed at
aggressively marketing Insured Mortgage Partners. The following example is
in one of the formats used:
A Safety-Conscious Investor s Dream ALL THE BENEFITS OF
GOVERNMENT - INSURED MORTGAGES . . . PLUS
SAFETY - AAA QUALITY Principal and base interest guaranteed by
instrumentalities of U.S. government. Base yield can increase but
never drop.
UPSIDE PARTICIPATION Participation features propel yield higher
as demand inflation drives up rents and property values while
investors are assured a maximum priority return.
HOLDING PERIOD Projected 8 to 10 years
LIQUIDITY Units will be NASDAQ traded within 12 to 36 months of
Partnership closing to accommodate the unforeseen investor
circumstance. . . .
The record contains various names for the two series which I
will refer to as Insured Mortgage Partners and Insured Mortgage
Partners 1B.
This undated material also reminded brokers that they would
receive 5.5% non-grid gross commission with 40% payout with 50%
retroactive volume bonus. (R s Ex. 14.)
======END OF PAGE 12======
YOUR BUYERS *All conservative investors *IRA and Keogh Investors
*CD and Treasury buyers *Pension Plans and Credit Unions *Large
Savings Accounts
(R s Ex. 14.)
In one piece of material dated in 1987, PaineWebber s D.I. Dept.
promoted Insured Mortgage Partners as a product that provided safety of
principal, a high initial yield that beats short-term CDs, liquidity, and
strong upside potential. (R s Ex. 15.) In material dated in 1988 or 1989,
it urged PaineWebber brokers to solicit sales of Insured Mortgage Partners
1B to clients who are adverse to risk, but do want premium returns (10-
13%) . . . It s perfect for retirement funding or as a CD alternative.
(R s Ex. 17.) Marketing materials issued in the late 1980s described the
holding period as 8 - 10 years to partnership liquidation, and asked
What Pays 7 - 7.5% with Attractive Upside AND is Guaranteed by the United
States Government. . . ? (R. Ex. 23.)
Mr. Gartz relies on PaineWebber s D.I. Dept. for his belief that the
underlying Ginnie Maes held by Insured Mortgage Partners either could not
be prepaid or had conditions which made prepayment unlikely so that the
yield on the units would not drop in response to falling interest rates
like individual Ginnie Maes, and that the eight to eight and a half percent
return could not go down but could increase. (Tr. 648-50.)
1. Ina A. Tourtellotte and Palma Pasqualini
In 1985, Mrs. Tourtellotte, a retired widow, opened accounts with Mr.
Gartz for herself and her mother, Mrs. Pasqualini, an 82 year old widow.
Mrs. Pasqualini depended on Mrs. Tourtellotte s advice in handling the
account. These were Mrs. Tourtellotte first brokerage accounts. She
selected Mr. Gartz because of his reputation in the community as someone
she could trust. Mrs. Tourtellotte put all her assets, $194,000, which
included the proceeds from the sale of her home in Connecticut, and $80,000
of her mother s assets in their respective individual PaineWebber accounts.
(Tr. 36, 43.)
Mrs. Tourtellotte told Mr. Gartz that her main concern was safety of
principal, and that this account and her part time employment were her only
sources of income. She informed him that she and her mother were widows
who depended on these assets for their livelihood. (Div. Ex. 21.) Mrs.
Tourtellotte followed all of Mr. Gartz s recommendations, and left it up to
him to decide what was best for her and her mother. (Tr. 38, 72.)
In the summer of 1991, things occurred which concerned Mrs.
Tourtellotte. For example, she had told Mr. Gartz she needed
funds to start a business, and thought he arranged for the money
to come from her account. When she received notices for payment
from PaineWebber that she did not understand, she asked Mr. Gartz
who told her everything was all right and not to worry. (Tr.
42.) In fact, Mr. Gartz had Mrs. Tourtellotte borrow the money
from PaineWebber on margin. In August 1991, she paid PaineWebber
interest at 10% on an average loan balance of $27,192. (Div. Ex.
12A.)
======END OF PAGE 13======
Mr. Gartz told Mrs. Tourtellotte that interest was high on PaineWebber
direct investments and there was no risk because the funds were government
insured. (Div. Ex. 21.) In July 1991, the Tourtellotte account owned
$75,000 of Insured Mortgage Partners 1B and $20,000 of Independent Living
Mortgage. Some 61 percent of Mrs. Tourtellotte s assets consisted of direct
investments. (Div. Ex. 12A.) The Pasqualini account owned Ginnie Mae
certificates and $25,000 of Insured Mortgage Partners. (Tr. 44-46.)
On her statement for August 1991, Mrs. Tourtellotte noticed a $12,403
withdrawal from her account and a $45,364 withdrawal from her mother s
account. (Tr. 42-46, 56-58.) Mrs. Tourtellotte was unaware of letters of
authorization dated August 14, 1991, authorizing transfer of these funds
for the purchase of Insured Mortgage Partners. (Tr. 48-51.) Neither Mrs.
Tourtellotte nor her mother signed the authorizations. (Tr. 49-50,
55.) Funds were transferred from Mrs. Tourtellotte s and Mrs.
Pasqualini s accounts to the account of Rudolph and Eunice Schmitt for the
purchase of Insured Mortgage Partner 1B at $100 a unit. (Div. Exs.
14, 18; Tr. 86-88.) The Schmitts were customers of Mr. Gartz who were sick
and wanted to liquefy their assets. When Mrs. Tourtellotte questioned Mr.
Gartz, he did not tell her that he had purchased direct investments but
said that PaineWebber was revamping its customer statements and the money
was in her account.
PaineWebber returned all the funds that Mrs. Tourtellotte and Mrs.
Pasqualini invested in direct investments, except the loan amount, after
Mr. Tourtellotte contacted an attorney and complained to PaineWebber in
April 1992. (Div. Ex. 21; Tr. 68-69.)
2. Louis Camill
Mr. Gartz was the account executive on the joint account of Louis J.
and Margaret L. Camill, which transferred $50,000 to the Marshall & Isley
Trust account on June 14, 1991. (Div. Ex. 31.) The trust was not a client
of Mr. Gartz. Louis Camill signed transfer papers to buy units of Insured
Mortgage Partners on August 8, 1991, and Lori Bremen signed for the seller,
the Marshall & Isley Trust for benefit of John Shomer Trust, on September
14, 1991. (Div. Ex. 30.) On December 19, 1991, 500 units were transferred
out of the Marshall & Isley Trust to the Camill account. (Tr. 204; Div.
Ex. 32.) None of the parties to the transaction testified at the hearing.
C. Pegasus Aircraft Partners II, L.P. ( Pegasus )
Pegasus was a 1989 offering of $145.6 million of limited partnership
units at twenty dollars per unit, with a minimum investment of five
thousand dollars. (Div. Ex. 70 at 1.) Pegasus was formed to acquire used
commercial aircraft and to lease them to commercial airlines. The offering
was limited to individual investors with a minimum annual gross income
The Order Instituting Proceedings does not allege that Mr.
Gartz forged his customers signatures on documents.
The funds were withdrawn, but according to the Division, the
units were not transferred from the Schmitt s account.
(Division s Proposed Findings of Fact at 18.)
======END OF PAGE 14======
and/or net worth. (Div. Ex. 70 at 4.)
The Prospectus noted that:
This Offering involves various material risks, including risks
associated with the ownership and leasing of aircraft, federal
aircraft regulation, state and local regulation of airports and
air carriers, general economic and business considerations,
federal income tax matters, the lack of liquidity because of the
absence of a market for the Units and material adverse tax
consequences under existing federal tax law if a public market
should develop. . . . The only persons who should subscribe for
Units are those who have adequate financial means to assume such
risks and to provide for their current needs and personal
contingencies and who can afford to bear the full loss of, and
who have no need for liquidity with respect to, their investment.
(Div. Ex. 70 at 3-4.)
Mr. Gartz recalled that PaineWebber s D.I. Dept. claimed that the
aircraft could probably be leased for ten years and then sold at the
purchase price because the planes would be modernized and maintained at a
high level by the lessees due to government requirements. (Tr. 650-51.)
Also, aircraft rentals would not be a problem even if a particular lessee
encountered financial difficulty because of the worldwide need for
aircraft. (Tr. 651.)
1. John Durig
In 1991, Mr. Durig opened two accounts with Mr. Gartz on the
recommendation of his father who was one of Mr. Gartz s customers. Mr.
Durig s PaineWebber accounts had about $250,000 in total assets, and he
also had retirement accounts at another brokerage firm. The activities at
issue involve Mr. Durig s trust account which he opened at PaineWebber on
March 15, 1991. Mr. Durig s new account form shows his investment
objectives listed in order of priority as growth, safety, income, and
speculation. (Div. Ex. 47; Tr. 512.) Mr. Durig believed his account
objectives to be growth, some liquidity because of college expenses, and a
reasonable return. (Tr. 509, 520.)
When he opened the account, Mr. Durig authorized the purchase of two
direct investments: $50,000 worth of R & D Partners III and $50,000 of
Independent Living Mortgage II. (Tr. 512; Div. Ex. 47.) His statement
for October 1991 shows ownership of these units and $50,000 worth of
Corporate Property Associates 11 which raised the percentage of direct
investments in the portfolio to 89.54 percent. (Div. Ex. 50A.)
Mr. Durig s January 1992 account showed that he owned Pegasus. (Tr.
513.) Mr. Durig did not authorize or sign the letter of authorization,
dated August 16, 1991, directing the withdrawal of $10,000 from his
account, and the transfer of $5,000 to Harry E. Allen and the transfer of
Mr. Durig s use of the term liquidity means being able to
get his money from the investment in about a month. (Tr. 522.)
======END OF PAGE 15======
$5,000 to Avelyn B. Booty for the purchase of Pegasus units. (Tr. 519-20.)
As a pilot aware of situations where bankrupt airlines terminated aircraft
leases, Mr. Durig would not have purchased Pegasus. (Tr. 514.) Mr. Durig
contacted officials at PaineWebber and it bought back the Pegasus
units. (Tr. 514-15.)
2. Robert A. and Leona F. Bliven
Neither Mr. or Mrs. Bliven nor Patricia A. Frericks, who the Division
claims were customers of Mr. Gartz, testified at the hearing. The evidence
is that on May 1, 1991, $25,000 was transferred from the Blivens account to
the Frericks account. (Div. Ex. 61; Division Findings of Fact at 23.) On
September 30, 1991, the Blivens signed transfer documents to buy 1,250
units of Pegasus from Ms. Frericks. Ms. Frericks signed transfer documents
to sell on the same date. (Div. Ex. 63.) The Pegasus general partner
approved the transfer on December 5, 1991, effective the first day of the
next quarter, January 1, 1992. (Id.)
D. PaineWebber Equity Partners II ( Equity Partners II )
Equity Partners II was an investment in commercial properties. (Tr.
651.)
In late August 1991, Mr. Gartz s customer Anna Innis bought $10,562
worth of Equity Partners II at par or $1.00 a unit from another of his
customers, Patricia A. Frericks. PaineWebber valued the units at $0.70 a
unit on Ms. Frericks s August 1991 statement. (Tr. 120-24; Div. Exs. 60,
61.)
Legal Conclusions
I find the Mr. Gartz willfully violated the antifraud provision of the
securities statutes in that in connection with the offer and sale of
securities, which involved instruments of interstate commerce, he employed
devices and schemes to defraud which caused Father Sullivan, Mrs. Adams,
Mrs. Tourtellotte, Mrs. Pasqualini, and Mr. Frazee, older unsophisticated
investors with limited assets, to believe that investing in Independent
Living Mortgage and Insured Mortgage Partners involved little risk and was
appropriate to achieve their investment objectives when Mr. Gartz knew, or
was reckless in not knowing, that this information was false.
Mr. Durig was part of a class action settlement with respect
to other direct investments which Mr. Gartz sold him. His
PaineWebber statement for August 1996 did not show a value for R
& D Partners III, but it valued Corporate Properties Associates
11 at over $50,000, and Independent Living Mortgage at between
$24,500 and $41,350. (Tr. 515-18.)
I have considered all the arguments advanced by the parties
and reject those that are inconsistent with this decision.
I reject Respondent s position that because the Order
Instituting Proceeding charged conduct between August 12, 1991,
(continued...)
======END OF PAGE 16======
Willfulness implies a deliberate action as distinguished from an
accidental, inadvertent, or negligent violation. United States v. Baldwin,
770 F.2d 1550, 1557-58 (11th Cir. 1985), cert. denied, 475 U.S. 1120
(1986). Courts have long held that willfulness in the context of Section
15(b) of the Exchange Act means no more than intentionally committing the
act that constitutes the violation. Tager v. SEC, 344 F.2d 5, 8 (2d Cir.
1965); C. James Padgett, 64 SEC Docket 312, 331 n.34 (March 20, 1997).
Liquid assets are cash or assets that can be immediately converted to
cash. Black s Law Dictionary 838 (5th ed. 1979). In the period August
1991 through January 1992, Mr. Gartz knew that that units of the four
PaineWebber direct investments at issue in this proceeding were illiquid in
that they were not publicly traded, they were not listed on any exchange or
with NASDAQ, and there was no guarantee of repurchase under the
reinvestment programs. Mr. Gartz acted fraudulently in that he lied and
told Mrs. Adams that Independent Living Mortgage was a liquid investment;
he made the same false representation to Mrs. Tourtellotte about Insured
Mortgage Partners; and he did not disclose to the Sullivans, Mrs. Adams or
to Mr. Frazee that the Independent Living Mortgage Prospectus, which he
read word for word, warned that the investment was appropriate only for
persons of adequate means with no need for liquidity, and that Independent
Living Mortgage would bear the risk of any decline in property
values. (Tr. 101-08; Div. Ex. 72 at 7, 14.)
Mr. Gartz knew these investors were all retired individuals who wanted
to invest in safe investments which would earn income needed for their
living expenses, yet he engaged in deceptive conduct which caused them to
put a large portion, and in some cases all, of their assets in direct
investments which he knew did not satisfy their investment objectives. On
(...continued)
until approximately January 1992, I should not consider record
evidence about the Sullivan, Adams, and Camill trades.
(Respondent s Post Hearing Brief at 2 n.2.) In the Sullivan
account almost all the parts of the transactions at issue
occurred within this period; funds for Mrs. Adams s purchase left
her account on August 8, 1991, and she received the units on
December 6, 1991; the seller in the Camill transaction signed the
transfer papers on September 14 and the Camill account received
the units in December 1991. The fact that part of the
transaction occurred outside the dates specified does not
disqualify the transaction.
Mr. Gartz denies making most of the representations, and
being responsible for the conduct, which his customers attribute
to him. Based on my observation of the witnesses and the many
discrepancies in Mr. Gartz s sworn testimony, I believe the
witnesses. For example, Mr. Gartz denies he told Mr. Frazee that
PaineWebber guaranteed payment of 10 percent interest on
Independent Living Mortgage, and that it would it buy back the
units for purchase price at the end of any three month period.
(Tr. 659-60.) However, Mr. Frazee s notes written
contemporaneously with the phone conversation support his
position. (Div. Ex. 9.)
======END OF PAGE 17======
Mr. Gartz s recommendation, and as noted he controlled these accounts, the
Sullivans invested their entire PaineWebber account, Mrs. Adams invested
almost all her total assets, Mrs. Tourtellotte invested over sixty percent
and later over eighty percent of her total assets, Mrs. Pasqualini invested
almost ninety percent of her total assets, and Mr. Frazee invested
approximately half the assets in his PaineWebber account, in risky,
illiquid securities. Mr. Gartz s own witness expressed serious concerns
about the participation in the securities industry of brokers who put a
large portion of a customer s assets in direct investments. (Tr. 578-79.)
Mr. Gartz s fraudulent conduct included false representations of
material issues including, for example, that Independent Living Mortgage
would earn ten percent when he knew that to achieve this projected return
some housing developments as yet unbuilt would have to be fully occupied,
and that the projection depended on the performance of Angeles, a developer
with no record of success in senior citizen housing. Also, in 1991, Mr.
Gartz should have been aware that the prospectus for Independent Living
Mortgage II dated August 8, 1990, reported that Angeles experienced a net
loss of over $6.7 million from operations in the first three quarters of
fiscal 1990. (Div. Ex. 73 at 22.) Material information is what a
reasonable investor would consider significant in making an investment
decision. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC
Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). This
information was significant to all the investors who specified income as a
primary investment objective. The Sullivans, for example, were depending on
their limited assets to cover the housing expense of Mrs. Sullivan who was
88 years old in 1991. Mrs. Adams s no nonsense manner and her attention to
detail cause me to believe that she made clear to Mr. Gartz that her
objective was to obtain income and not to incur any risk with her
principal. (Tr. 227, 229.) I find her testimony persuasive that she did
not provide Mr. Gartz with the exaggerated financial information on her new
account form. (Tr. 223-26.) Mr. Gartz s explanation that he got the
information from the late Mr. Adams is unpersuasive because the account was
for Mrs. Adams and Mr. Adams had been dead for several months.
Violations of Section 10(b) of the Exchange Act and Section 17(a)(1)
of the Securities Act require a finding of scienter, a mental state
embracing intent to deceive, manipulate or defraud, which can be satisfied
by a showing of recklessness approaching intentional conduct. Ernst & Ernst
v. Hochfelder, 425 U.S. 185, 193 n.12 (1976); Hollinger v. Titan Capital
Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990), cert. denied, 499 U.S. 976
(1991); Woods v. Barnett Bank of Ft. Lauderdale, 765 F.2d 1004, 1010 (11th
Cir. 1985); Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 115 F.3d
1127, 1129 (3d Cir. 1997). The overwhelming evidence is that between
August 12, 1991, and January 1992, when he recommended that his customers
purchase these direct investments, Mr. Gartz knew, or was reckless in not
knowing, that they were not liquid, safe investments.
The persuasive evidence is that Mr. Gartz had reasons other than the
buyers best interests in making these sales. Mr. Gartz had the Sullivans
buy units of Independent Living Mortgage because he was under pressure by
another customer to sell the units. Elsie Barker, who sold the units to
the Sullivans, had been a customer of Mr. Gartz. In early 1991, Mr.
Ferrin, Ms. Barker s grandson and the executor of her estate, threatened to
report Mr. Gartz to PaineWebber if he did not liquidate the direct
======END OF PAGE 18======
investments in Ms. Barker s account, including $69,000 worth of units in
Independent Living Mortgage. (Tr. 117-19, 171-72, 342-45.) Mr. Gartz
could not find buyers for the units, so he had PaineWebber in effect buy
back some of the units in February and March 1991 creating a debit in the
account. (Tr. 170-72.) Once the estate cashed the check, the only
way to eliminate the debit in the account was to sell the securities in the
account. (Tr. 175.) The paperwork documenting the transfer of the units
from the Barker account to the Sullivan account is unusual and raises
questions. (Tr. 170-80.)
Mr. Gartz further willfully violated the antifraud provisions when he
caused the Sullivans, Mrs. Adams, and Mr. Frazee to pay $10 a unit for
Independent Living Mortgage units when he knew, or was reckless in not
knowing, that units were available for less than this amount.
PaineWebber s DIN program, which was available to Mr. Gartz, indicates six
sales of Independent Living Mortgage in August 1991 ranging from a low of
$6.98 a unit to a high of $8.00 a unit, and seven sales in November 1991
ranging from a low of $7.50 a unit to a high of $9.50 a unit. (Div. Ex. 67
at 15-16; Tr. 400-04.)
Mr. Gartz offered no reason why he did not check PaineWebber s DIN
system which would have shown offers to sell Independent Living Mortgage
units at less than $10 a unit in August and November 1991 when he arranged
for the purchase by the Sullivans, Mrs. Adams, and Mr. Frazee. (Tr. 700.)
PaineWebber s procedures called for account executives to consult the DIN
screen, but it was not required. However, it was understood that a
representative would get the best price for the customer - the lowest price
for buyers and the highest price for sellers. (Tr. 276.) Mr. Gartz had a
duty to obtain the best price for his customers, and his failure to do so
in these circumstances was a fraudulent act.
It appears that the account was put in a debit position when
the estate executor was allowed to withdraw $183,214.59 in
February 1991. (Tr. 170-74.) Transfer of the Independent Living
Mortgage units to the Sullivan account occurred on December 19,
1991. (Tr. 177-79.)
According to the Division, because the transfer of funds
left very little assets in the Sullivan account for several
months, Mr. Gartz arranged a transfer of $5,000 from another
customer, Marjorie Moore, into the Sullivan account in exchange
for 500 shares of Independent Living Mortgage. Mr. Gartz then
issued the Sullivans a check for $1,250 from the $5,000.
(Division s Proposed Findings of Fact at 13-14.) Father Sullivan
knew nothing about the sale, and believed the October 24, 1991,
check for $1,250 was the quarterly interest on Independent Living
Mortgage. (Div. Ex. 36 at 24-26.)
Under the shingle theory, investors are entitled to rely
on the implied representation that they will be dealt with
fairly, honestly and in accord with industry standards. Trost &
Co., 12 S.E.C. 531, 535 (1942); Duker & Duker, 6 S.E.C. 386, 388-
89 (1939). See also, Thomas L. Hazen, The Law of Securities
(continued...)
======END OF PAGE 19======
For all these reasons, Mr. Gartz also acted fraudulently when he
arranged for (1) Anna Innis to pay $1.00 a unit for Equity Partners II in
August 1991, when PaineWebber valued the units at $0.70 on the seller s
account statement, and when the DIN program showed sales in the month at
between $0.28 and $0.45, and (2) Mrs. Tourtellotte and Mrs. Pasqualini to
buy Insured Mortgage Partners 1B at $100 a unit in August 1991 when the DIN
program showed the previous three sales in June and May occurred at between
$70.25 and $95.56 a unit. (Div. Ex. 67; Tr. 120-23.)
Even if you accept Mr. Gartz s claim that Mr. Durig authorized the
purchase of Pegasus units, which Mr. Durig denied, Mr. Gartz s conduct was
fraudulent in that he knew Pegasus did not fit Mr. Durig s investment
objectives of income, safety, and liquidity. The Pegasus Prospectus spelled
out the considerable risks involved and specified that the investment was
for persons with no need for liquidity. (Div. Ex. 70 at 4.) Moreover,
by 1990 and 1991, Mr. Gartz knew that certain airlines that leased
airplanes from Pegasus had filed for bankruptcy, and that Pegasus units
were neither listed on the NASDAQ nor publicly traded. (Tr. 109-16; Div.
Exs. 81, 82, 83.) Moreover, in August 1991, he arranged for Mr. Durig to
pay the original offering price of twenty dollars a unit when sales in the
month occurred at a low of $17.09 to a high of $19.00. (Div. Ex. 67.)
I reject Respondent s claim that he did not act with scienter because
he relied on materials supplied by PaineWebber, a firm that in 1991 had a
very good reputation in the industry. (Tr. 618.) PaineWebber s marketing
materials for these direct investments consisted of indefensible
hype. Some of the materials in evidence bear no dates and those
that have dates were issued in 1987 through 1989, well before August 1991.
(R s Exs. 10, 11, 13, 15, 16, 17, 22.)
The preponderance of the evidence does not establish that Mr. Gartz
relied on these materials when he acted illegally. Mr. Gartz testified that
he relied on the materials to some extent. (Tr. 645.) The weight of the
evidence is that Mr. Gartz knew, or was reckless in not knowing, by August
(...continued)
Regulation, 423-28 (2d ed. 1990). Investors can be deceived by
undisclosed conduct that is inconsistent with this
representation. See, e.g., Charles Hughes & Co. v. SEC, 139 F.2d
434, 437 (2d Cir. 1943), cert. denied, 321 U.S. 786 (1944).
The evidence concerning the Camill purchase is insufficient
to show illegal conduct.
The following statement from a one-page circulation touting
Insured Mortgage Partners 1B, quoted in the format in which it
appeared, stated:
Sales Incentives: * 5.7% commission - 40% payout with 10%
volume bonus.
* Broker residuals at $100,000 of sales in
the product.
* The Choice is Yours Incentive Trip (Monte
Carlo, France, Vail, Colorado or BOTH.)
(R s Ex. 12.)
======END OF PAGE 20======
1991 that much of the marketing information that the D.I. Dept. had
supplied to PaineWebber s representatives was inaccurate. Mr. Gartz
recommended that the Sullivans buy Independent Living Mortgage at the same
time he was having trouble selling this and other direct investments for
at least two others customers: Sarah Coffey and the Barker estate. Ms.
Coffey directed Mr. Gartz to sell her direct investments in April 1991. He
estimated it took him about six months to do so. (Tr. 117-18.) The
determinative fact is that Mr. Gartz lied, misrepresented, or did not
disclose to investors material information which he knew or was reckless in
not knowing.
The Division places great emphasis on the unsuitability of Mr. Gartz s
activities citing Clark v. John Lamula Investors, Inc., 583 F.2d 594, 600
(2d Cir. 1978), for the proposition that violations of the antifraud
provisions occur where the broker recommended the investment even though he
knew or reasonably believed that the investors were unsuitable. Since Mr.
Gartz s activities violated specific provisions of the securities statutes,
there is no reason here to take up the limited Commission case law on
suitability, a subject more often addressed by the self-regulatory
organizations.
Public Interest
The final issue is what Commission action is appropriate in view of
the findings. Since Mr. Gartz has been found to have violated the
antifraud provisions of the securities statutes and rule thereunder, a
cease and desist order pursuant to Section 8A of the Securities Act and 21C
of the Exchange Act is appropriate.
I reject Respondent s unsupported claim that Section 504 of the
Rehabilitation Act of 1973 ( Rehabilitation Act ) prohibits the imposition
of any penalty or sanction against Mr. Gartz because it would constitute
discrimination on the basis of a disability in violation of the
Rehabilitation Act. (Respondent s Post Hearing Brief at 11.) Section 504
provides that no otherwise qualified handicapped individual shall, solely
by reason of his handicap, be excluded from participation in, be denied the
benefits of, or be subjected to discrimination under any program or
activity receiving federal financial assistance. I find Section 504
inapplicable to this situation where a regulatory agency is acting in the
public interest to protect investors. Finally, the case law as
cited by the Division supports its position that the Rehabilitation Act
The Division would bar Mr. Gartz from association with a
broker-dealer, investment adviser, investment company or
municipal securities dealer; order him to cease and desist from
his fraudulent activities; and require him to pay an appropriate
Second Tier penalty. (Division s Reply Brief at 22-23.)
Respondent maintains that the Commission should impose no
sanctions and dismiss the proceeding. (Post Hearing Brief at 10,
12.)
The evidence does not show that Mr. Gartz s illegal conduct
occurred while he was under the influence of alcohol or that his
alleged disability caused his actions.
======END OF PAGE 21======
does not limit the Commission s authority. Community Television of
Southern California v. Gottfried, 459 U.S. 498 (1983).
Established criteria for determining what sanctions are appropriate in
the public interest in proceedings such as this, instituted pursuant to
Sections 15(b) and 19(h) of the Exchange Act, include deterrence and:
the egregiousness of the defendant's actions, the isolated or
recurrent nature of the infraction, the degree of scienter
involved, the sincerity of the defendant's assurances against
future violations, the defendant's recognition of the wrongful
nature of his conduct, and the likelihood that the defendant's
occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other
grounds, 450 U.S. 91 (1981); Richard C. Spangler, Inc., 46 S.E.C. 238, 254
n.67 (1976). The severity of a sanction depends on the facts of each case
and the value of the sanction in preventing a recurrence. Berko v. SEC,
316 F.2d 137, 141 (2d Cir. 1963); Richard C. Spangler, Inc., 46 S.E.C. at
254 n.67; Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
Mr. Gartz s actions were blatant in that over a five-month period, by
actions that were willful and displayed a high degree of scienter, he
illegally took advantage of seven investors who had very little knowledge
of the securities markets. These unsophisticated investors trusted Mr.
Gartz to control most or all the assets they had accumulated over a
lifetime. They accepted Mr. Gartz s professional judgment based on his
position as local branch manager of a major brokerage firm, his experience
in the industry, and his good reputation in the community. Mr. Gartz s
fraudulent actions are exacerbated by the fact that he knew that most of
the older investors needed to keep their assets safe because they needed to
earn income to support them in retirement, and that the younger investors
wanted income for their children.
Since Mr. Gartz does not admit that he acted illegally, it is probable
that if allowed to participate in the industry in an unsupervised capacity
he will continue his illegal activities. Inexplicably, Mr. Gartz expressed
no remorse for having betrayed the confidence of his customers. Yet, while
claiming he acted in reliance on PaineWebber s misleading marketing
materials, Mr. Gartz is sorry for causing trouble for PaineWebber, which
terminated his employment.
The securities industry depends on the integrity of its members. The
record indicates that Mr. Gartz does not tell the truth. He blamed the
events that are the basis of this proceeding on his failure to complete the
necessary paperwork. (Tr. 684, 746.) He stated under oath that
PaineWebber s Naples office always received internal ratings that were
above satisfactory. Later he claimed he forgot that for 1990 the office
was rated below standard, a rating lower than unsatisfactory. (Tr. 723-
24.) He told PaineWebber s internal auditors that he needed time to find
the documentation for the transactions involving direct investments, but he
failed to produce it. (Tr. 208-09.) Several of his misrepresentations to
customers have been noted, but there are others. For example, he claimed
to have always told his customers that the limited partnerships were long-
term investments with a potential for repurchase in emergencies or where
======END OF PAGE 22======
people had to have their money back through a repurchase program, i.e., the
possibility that the partnership would buy units back depending on demand
for them. (Tr. 116, 660-61.) However, almost every customer witness
testified that Mr. Gartz represented that direct investments were liquid in
that they could sell them in a reasonable time.
Despite Mr. Gartz s denial, the evidence is persuasive that he had a
check sent to Mr. Ferrin from the Elsie Barker account before he sold some
of her direct investments. (Tr. 118.) Mr. Ferrin, executor of Mrs.
Barker s estate, threatened to report Mr. Gartz for taking too long to sell
the assets in the account, and Mr. Gartz acknowledged he had trouble
finding buyers. Mr. Gartz admitted to PaineWebber s Deputy Director of
Compliance that they cut him one check or a series of checks to
effectively buy back the partnerships from, from him or from the estate.
(Tr. 171.)
I considered the following circumstances to be sufficiently mitigating
so as to lower the maximum available sanction of a bar from association
with a broker-dealer to a bar with the right to reapply after two years for
admission in a non-supervisory, non-proprietary capacity. Prior to
these transgressions, Mr. Gartz had not been the subject of any customer
complaints or regulatory action during his twenty years in the securities
industry in which he held a high profile position and had a large number of
clients. Mr. Gartz s actions were not motivated by personal financial gain
because he did not profit from his illegal activities. Mr. Gartz was and
is excessively loyal to PaineWebber. His status at the broker-dealer was
very important to him, and PaineWebber encouraged its registered
representatives to sell direct investments and recognized those who did.
Mr. Gartz is 53 years of age, a veteran with an enviable record of military
service and civic and charitable activities, who has sought treatment for a
serious drinking condition.
I find it is not in the public interest to impose a civil penalty as
the Division requested. Several of the public interest
considerations listed in the statute as a guide to when a penalty should be
imposed are missing or are satisfied by the other action taken.
(Division s Post Hearing Brief at 33.) There has been no showing that Mr.
Gartz s customers suffered financial harm, or that Mr. Gartz was unjustly
enriched. Mr. Gartz lost his position at PaineWebber and his wages went
from above $200,000 in 1990 and 1991, to less than $10,000 in 1992 and
1993. (R s Ex. 33.) In 1995, he had earnings of about $28,000 from
Northwestern Mutual Life Insurance Co. Mr. Gartz s wife has had to seek
part time employment, and in 1994 he had three dependents. (Id.) The
guidance provided by the case law is that the Commission often has found a
civil penalty to be in the public interest where respondents have a history
I deny the Division's requests that I bar Mr. Gartz from
association with any investment adviser, investment company, or
municipal securities dealer because this proceeding was
instituted pursuant to Section 15(b) of the Exchange Act which
does not provide for such sanctions.
The Division states no reasons for its request except that
it is allowed in this situation.
======END OF PAGE 23======
of violations and past regulatory actions or injunctions have not achieved
the desired goal of compliance. First Securities Transfer Systems, Inc.,
60 SEC Docket 441, 447-48 (Sept. 1, 1995); New Allied Development, 63 SEC
Docket 807, 822 (Nov. 26, 1996). I therefore consider it highly significant
that Mr. Gartz has no history of prior violations. In these circumstances,
barring Mr. Gartz from association with a broker-dealer for a minimum of
two years with the right to reapply in a limited capacity will serve as a
deterrent.
Record Certification
Pursuant to Rule 351(b) of the Commission s Rules of Practice, 17
C.F.R. 201.351(b) (1996), I certify that the record includes the items
set forth in the record index issued by the Secretary of the Commission on
February 14, 1997.
======END OF PAGE 24======
Order
Based on the findings set out above, I ORDER, pursuant to Section 8A
of the Securities Act and Sections 15(b), 19(h), and 21C of the Exchange
Act, that Frederick C. Gartz:
1. shall cease and desist from committing or causing any violations or
any future violations of Section 17(a) of the Securities Act, and Section
10(b) of the Exchange Act and Rule 10b-5 thereunder; and
2. is barred from being associated with any broker or dealer, and from
being associated with a member of a national securities exchange or
registered securities association, with the right to reapply in a non-
supervisory, non-proprietary capacity in two years.
This order shall become effective in accordance with and subject to
the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R.
201.360 (1996). Pursuant to that rule, a petition for review of this
initial decision may be filed within 21 days after service of the decision.
It shall become the final decision of the Commission as to each party who
has not filed a petition for review pursuant to Rule 360(d)(1) within 21
days after service of the initial decision upon him, unless the Commission,
pursuant to Rule 360(b)(1), determines on its own initiative to review this
initial decision as to any party. If a party timely files a petition for
review, or the Commission acts to review as to a party, the initial
decision shall not become final as to that party.
__________________________
Brenda P. Murray
Chief Administrative Law Judge
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